They are back in the news, powerful institutions that you may think should be invincible. How can banks go bust, then? Well, for a variety of reasons, including, the following.
Poor Management
If the owners of a bank manage it poorly, it may make bad decisions regarding lending and investments, leading to losses. Like any company, they rely on those in charge managing them professionally, without unnecessary risks. This is often not the case in the financial sector, and banks are no exception.
Economic downturns
Economic downturns can result in a decline in the value of assets that banks hold, leading to losses.
Fraud
Fraudulent activities, such as embezzlement or insider trading, can lead to financial losses for the bank. You will see by searching that there are a few famous cases of this happening. Not surprisingly, wiping huge value off a bank value with such activity will incur disastrous consequences.
External shocks
External shocks, such as natural disasters, terrorist attacks, or pandemics, can disrupt the economy and lead to losses for banks. Whilst we tend to view bank collapses as the fault of those who run them, this is not always the case. Sometimes it can be little more than bad luck – at least in part.
How Can Banks Go Bust? Liquidity problems
Banks need access to liquid funds to meet the demands of depositors who want to withdraw their money. If a bank is unable to raise funds to meet these demands, it may fail. The money has to be there for banks to function.
How Can Banks Go Bust? Credit risk
Banks make loans to individuals and businesses, and if these loans are not repaid, it can lead to losses for the bank. This is a key factor in many bank struggles over the past few decades. They take risks that do not need to be taken, in pursuit of further profit.
Consequences
When a bank fails, it may be taken over by a government agency, such as the Federal Deposit Insurance Corporation (FDIC) in the United States, or it may be sold to another financial institution. In some cases, the bank may be liquidated, and its assets sold to pay off its debts.
Credit Suisse
UBS has found itself caught up in market turmoil over a key method of bank funding after its £2.7bn takeover of Credit Suisse. Prices of its so-called AT1 bonds have plummeted amid a crisis of confidence in the debt instrument. Credit Suisse had the value of its own $17bn worth of AT1 bonds wiped out under the terms of its takeover enforced by Swiss regulators.
However, now investors are demanding higher returns to take on the debt, with yields surging today from just over 11pc to nearly 17pc. It comes as markets demonstrate growing doubts over the takeover designed to avert a global banking crisis.
The European Central Bank has said the European financial system is “resilient” and has sufficient liquidity, as banking shares plunged. Meanwhile, oil and gas prices have tumbled on fears the fallout would slow the global economy.
